By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

Dear Clients,

2007 had provided very little in terms of surprises up until Tuesday – when the Dow dropped 416 points which was the biggest percentage drop in the index in nearly 4 years. Here is how our portfolios have stacked up against the averages YTD:

Core Portfolio………………….……….……..3.0%
Focus Portfolio……………………….…..……2.7%

S&P (VFINX)………………………………….….0.2%
NASDAQ (QQQQ)…………………………..…0.5%
Benchmark (Couch Potato Portfolio)…….1.2%

So far, so good. I’ve been able to eak out some decent profits solely by utilizing alternative strategies. As you know, I have no equity exposure in your accounts as I’m fearful that we are on the brink of a significant bear market that could devastate equity portfolios. It will be a few more weeks before I can definitely say that Tuesday was the beginning of the bear market that I’ve been anticipating. If it is, we can expect a few more days like it.

As a prudent investment advisor, I like to play it safe which means always looking for what could go wrong with my portfolio. In that vain, I’ve noticed a specific vulnerability in your account. Despite having no current equity exposure (Actually, I’ve maintained a mild short-equity bias), I am growing increasingly fearful that my strategy may not be able to protect you from short-term losses in the event of an equity bear market. Please allow me to try and explain.

The current bull market in equities and bonds has been prolonged by central banks worldwide injecting massive amounts of liquidity in the world’s markets. This excess liquidity has not only boosted prices in equities and bonds, but also in commodities including gold (GLD) and silver (SLV). If a liquidity “crunch” is responsible for triggering the bear market in equity and bonds, it stands to reason that it may result in a pullback in commodities as well - which could lead to losses in my model portfolios.

Excessive liquidity in the markets has created an anomaly where commodities and equities are positively correlated – at least for the short-term. Historically, commodities have show a negative correlation (approximately -25%) to equities and a nearly 100% negative correlation to bonds. However, this historical correlation has broken down since June of 2004. Since then, equities, bonds and commodities have seemingly gone up and down in lockstep – including the mild correction last May. Therefore, if a bear market in equities is now upon us, the price of everything, including gold and silver, may go down. This is why I justified maintaining a slight short-bias in equities in your portfolio over the last couple of months – to offset the risk of a liquidity crunch in precious metals.

However, in the long-term, historical correlations must return to normal. If equities go down, Gold and Silver will eventually go up. So, we may take some hits in precious metals in the short-term, but eventually our positions in GLD and SLV will continue their long-road higher. I still contend that we will see Gold hit its all-time high of $870 within the next 18 months – and it should take Silver along for the ride.

I appreciate your patience and I’ll continue to “keep both eyes on the road” for you.

All the best,

Matt

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